Room for One

Room for One: Industry and standardization, by Mark Chussil

Yahoo Posts Loss as New Chief Plots Strategy,” said the Wall Street Journal.

It is, of course, good news for Yahoo employees and shareholders that new CEO Carol Bartz is a capable person working hard to turn the company around. It is worth asking, though, what is reasonable to expect from Yahoo, and even whether a turnaround is possible. We’ll focus on Yahoo Search (the main prize Microsoft sought in its acquisition bid a year ago) in its competition against Google and Microsoft.

We often think of industries on a spectrum from extremely differentiated to commodity: art, cars, airlines, gasoline, raw materials. Most industries, including commodities, have room for multiple competitors. However, in some industries, there is only economic room for one.

There was room only for one high-definition video disc, which is why Blu-ray beat HD-DVD rather than the two co-existing. (We’re talking about competition between the Blu-ray consortium and the HD-DVD group, not about brands of players.) At this point Blu-ray is pretty much invulnerable to attack from a competing disc format. It is, however, vulnerable to radically different technologies, such as streaming video, that offer serious advantages to movie-studio and home-viewer customers.

The defining characteristic of such industries is standardization, not differentiation or commoditization. Industries may become standardized when there is increasing value to the customer as a product or technology becomes more-widely adopted. For instance, a major benefit of Microsoft Office is that everyone has Microsoft Office, which make it easy to share files and advice.

Conversely, industries may not become standardized when there is decreasing value to the customer if the market were to congeal around a single supplier. Airlines want both Boeing and Airbus to stick around because they want to buy better and better aircraft and retain some negotiating power.

Now think from the suppliers’ perspectives. If you’re the one on top in a standardizing industry, your customers become increasingly easy to keep and incremental sales are increasingly easier to make. The lagging competitor is of decreasing value to the customer because it’s the lagging competitor, and so customers get harder to keep and incremental sales get harder to make. Blu-ray and HD-DVD, neck and neck; then Blu-ray pulls ahead by a nose; then whoosh, Blu-ray zooms into the future and HD-DVD sinks into history. (We congratulate the HD-DVD backers for not wasting money dragging out the endgame.) The zoom looks sudden, but it isn’t. It’s a positive feedback loop: the more X happens, the more X happens.

In short, achieving critical mass in a differentiated or commoditized industry means you stay in the game, and achieving critical mass in a standardized industry means you’ve won the game.

Google reaps those increasing-value benefits among the advertisers to whom it sells. Google’s profits (see Gross Galactic Product) give it the wherewithal to improve its technology and offerings. Yahoo suffers from the benefits Google reaps.

Standardization means dominance but not necessarily monopoly. Office alternatives from Apple, Linux, and others aren’t dead yet, or even mortally wounded. Intel is inside but AMD isn’t locked out. Standardization does mean, though, that it is exceptionally difficult to dislodge the incumbent. Witness how hard it’s been for the USA to replace analog television with superior digital technology. Such difficulties are critical for setting performance expectations for any company in Yahoo’s position: standardization means that once the game is lost, a rematch is unusually and asymmetrically expensive for the challenger.

Perhaps Microsoft (suffering from its own search-engine blues) read this handwriting on the wall when it offered to buy Yahoo exactly one year ago for over $44 billion. The combined Yasoft or Microhoo search business presumably would have a better shot at taking on Google than would either company alone. (Which doesn’t mean that they’d win; it just means they’d have better odds.) Apparently former Yahoo CEO Jerry Yang didn’t think so. Apparently Ms. Bartz doesn’t think so either, because she said she didn’t join Yahoo to sell all or parts of the company. Of course, Mr. Yang and Ms. Bartz may be right; they know Yahoo and search better than I do. On the other hand, there is reason to believe that the ordinary tools of business analysis are not telling them what they need to know.

Conventional tools — history, financial analysis, trend lines, and so on — are inadequate to analyze or even recognize standardization. Historical sales trends, for instance, may reveal a modest gap in sales growth for us and our key competitor, and it seems logical that if we work hard we can close that gap. But if standardization is happening the presence and persistence of any gap at all makes it increasingly difficult to catch up.

Thus, conventional analysis with conventional tools can paint an overly rosy picture of Yahoo’s prospects to match or beat Google, which in turn is a recipe for wasting a lot of time and money.

How overly rosy is Yahoo’s picture? How much should Yahoo spend? How far can it go? I can suggest how Ms. Bartz and her colleagues might get valuable insight into those questions before they commit time and money.

What Yahoo strategists need (and perhaps already have) is strategy-simulation and –analysis models that take into account factors related to standardization.  The factors include “soft” customer purchase decision-making (e.g., the Office benefit of easy file sharing), customer loyalty, inertia, and switching costs (e.g., time to learn a new system), the effects of improved product features, and so on. ACS simulation models have taken such factors into account for many years, so we know it’s possible.

As a strategist you can learn even without such models simply by asking where in your industry there are positive feedback loops (things get more extreme) as opposed to negative feedback loops (things dampen out). It’s not about getting the right descriptive statistics from the past. Rather, it’s about thinking through why customers, competitors, and technologies interact as they do.

What’s in store for Yahoo’s search business? I’m not privy to relevant information and I have not performed a strategy analysis of their businesses. Also, the point of this essay isn’t Yahoo per se; rather, the point is that industry standardization is conceptually understandable, strategically important, and invisible to conventional analysis.

That said, if I were a Yahoo investor I would be concerned about danger signs.

  • It is possible for a strong #2 to change the game and roar past #1. However, Google is not sitting still and would be tremendously difficult to derail even if they were sitting still. They’ve even become a verb, which further illustrates standardization.
  • It’s not enough for Yahoo to be different from Google. It must be clearly, demonstrably superior in ways that matter to users (those of us who use search engines) or to customers (advertisers), just as streaming video poses a credible threat to Blu-ray because it offers instant access to huge libraries.
  • I understand the public-relations and investor-management reasons for saying Yahoo won’t be sold or broken up, and I don’t know what people say behind closed Yahoo doors. If, though, those public statements reflect a true unwillingness to consider important strategy options, that’s not good.
  • Ironically, pressure from investors for quick results can be self-defeating for the same reasons that pressure to make short-term numbers hurt Detroit.

More than a turnaround is in order when the core problem is standardization around a competitor. Yahoo must come up with a compelling reason why we need two search companies or why advertisers and consumers should switch to Yahoo from Google. And if they don’t eventually team with Yahoo, Microsoft must show why we need three.

Update, September 6, 2011. All Things Digital reports “Carol Bartz Out at Yahoo; CFO Tim Morse Named Interim CEO.” The reason, of course, is poor performance. For the reasons above (which might qualify me to say a sad “I told you so”), I’m not sure it was reasonable to expect Ms. Bartz to turn the company around. And I don’t expect anyone else to either. Perhaps Yahoo’s board of directors doesn’t too, because the article says they’re “ready to listen to any serious offers.” For a new boss and/or partner to work, there have to be big, game-changing changes.

Update, January 25, 2011. The Wall Street Journal reports “Yahoo Struggles to Keep Pace.”

Update, May 2009. Chrysler has declared bankruptcy and GM might be clearing its throat to declare the same. Both are rationalizing by shedding brands. We might take that rationalization idea one step further and wonder how much room there is for multiple American car makers. Yale President Rick Levin (also the Frederick William Beinecke Professor of Economics) had this to say in the May/June 2009 issue of Yale Alumni Magazine:

I think the optimum number of U.S. auto companies is one. Maybe two, but certainly not three. The world-wide auto industry is going to shrink, to a Chinese firm, a Japanese firm, an Indian firm, a Korean firm, a European firm — and an American firm, I hope, but there’s a chance there will be zero U.S. auto companies if we don’t do this [the bailout] right.

I don’t believe he’s talking about the standardization effects I mentioned above. What’s germane, though, is the idea of how much room there is for American auto companies. What’s germane also is the need to think through what is rational to expect. The gap between expectations and performance is where fortunes are won and lost.


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